The Free Market: A Talk with Commodities Expert Leo Melamed

A talk with the former chairman of the Chicago Mercantile Exchange on what caused America's financial situation.

By Douglas Goldstein

First Publish: 8/9/2011, 6:04 PM

Leo Melamed is the author of the book called For Crying Out Loud: From Open Outcry to the Electronic Screen. He has been a leader in the world of commodities, was chairman of the Chicago Mercantile Exchange and the founder of the consulting firm, Melamed & Associates.

During WWII, his family was among the Jews saved by the Japanese General Consul Chiune Sugihara, who issued many transit visas before leaving Europe for Japan. Many years later, Melamed attributed the origin of his ideas about finance to his childhood wartime experience.

Leo Melamed: General Consul Sugihara is one of the Righteous Gentiles. He’s featured by Yad Vashem as well as at the United States Holocaust Museum. He did this on his own, without any real purpose of getting any advantage from it. In fact, he was later accused by the government of Japan as having done something that they didn’t want him to do, and he took it upon himself to issue over 3000 visas to stranded Jews.

We were in Europe after the World War broke out, and we had been running, literally running, from the Germans who had captured us, but we escaped and not because of me as I was only seven years old. It was because of my parents, who were music teachers at the time, but my father and mother were quite brilliant and knew enough to get out. We were so fortunate to be among the very few people who escaped from Lithuania or Poland.

Mr. Sugihara was truly a remarkable individual, and I’ve never forgotten that. During those travels, as a seven-year-old who had parents who were teachers, I learned a great deal because my father took time out of the horrors of the war to teach us songs or whatever he could because I often wasn’t in any school. The reference that I’ve often given as the idea that eventually caused me to launch financial futures markets came from events that my father initiated when we were in Lithuania.

The very first time that we were there, my father held up a zloty, which is the Polish unit of trade, and asked me if I knew what that was. I said, “Sir, that’s a zloty.” And then he held up another coin and he said, “You know what that is?” and of course I did not. He said, “That’s the lit,” which is the Lithuanian currency, and he said that the government told the world that those two currencies are equal in value.

“Do you think they are equal in value?” he asked. I said, “I suppose so.” And he said, “Why don’t we go and find out?” and so he took me by the hand. Remember that I’m seven years old. He took me by the hand and we went to a bakery. Then, Lithuania was still a pretty safe country before the war hit them. He asked the baker for a loaf of bread and how much it was, and the baker said, “It is one lit,” as best as I can remember. My father said, “Okay I’ll buy it,” and he gave him a zloty, and the baker said, “No, that’s a zloty. It takes two zloty if you want to buy this bread and only one lit.”

That illustration resonated with me, and my father repeated it with respect to the ruble and then in respect to the yen as we raced across the world. During that time, it kind of stuck in my memory that real market values are determined by the people, along with purchasing power.

It’s not what the government may want to tell us its value is, but what it’s really worth by virtue of what you can buy with it. And that was something that resonated years later in 1970-1971.

I was the chairman of the Chicago Mercantile Exchange and I was a lawyer by profession, so I really wasn’t an economist. But I was well-read in matters of economics as it related to the currency markets that were leveling at that time, and I thought that a foreign currency futures market would have a great a reason to exist. And that’s how it came into my mind again that a free marketing currency is probably what the world may need.

Douglas Goldstein: A lot of fingers have been pointed at the perceived failure of the free market system, but you’ve argued that the opposite is not the case. Do you think that the free market that we all grew up on is really still okay, or is it time to find a different approach?

Leo Melamed: I would like to see whose fingers are pointing and what the history of the people that are pointing the finger is before I would accept what they’re pointing or saying, because they are totally confused and wrong.

The free market didn’t cause the meltdown. There were some bad people using instruments that they should’ve known better or how to use them that brought the market down, but mainly, believe it or not, it was the government themselves that brought the market down with the conditions that caused the 2008 meltdown.

They were not created by the free market system. In fact, they were created by government. It wasn’t the free market that created such low interest rates in the world that everybody was seeking a way to find a better interest rate return.

Who creates interest rates? It is the government, the central bank. In the United States’ case, we know that the interest rates were extremely low and the consequence of that easy money creates all kinds of unintended consequences. And then on top of that, in the United States, there was this feeling or philosophy with many people in Congress that everybody in the United States should own a home.

This is a nice goal, except everybody in the world can’t own a home because maybe they can’t afford a home. You’ve got to have money, you’ve got to have a job, you’ve got to have some assets, and you’ve got to be able to afford the mortgage.

What Congress did was to create Fannie Mae and Freddie Mac, which are two major institutions in the United States that are willing to buy any kind of mortgage that was being offered to them, including the mortgages that were created through derivatives. It was not the fault of derivatives, but the fault of the situation. They created a market that allowed people to buy a home that they couldn’t afford and shouldn’t have bought without down-payments or without a job. Of course, the net result eventually was a bluff, as you would expect. And then when that bluff was called, it took everything with it.

You couple that with the fact that government allowed investment bankers to leverage debt-to-asset ratios far beyond the norm. Now, who does that? That’s the law and that’s the government allowing them to go from a normal 12 to 15:1 ratio to 50:1 ratio and they took off the limitations, the SEC, which is the Security Exchange Commission.

So what I’m giving are the real underlying reasons - that sure Wall Street took advantage of the situation, and some of them are bad guys and some of them belong in jail. But really they didn’t create the situation, they took advantage of the situation that was created by government. And so now to turn around and blame the free market, that’s wrong.

Without the free market, Israel wouldn’t be in existence, and neither would the United States be as strong as it is, and nor would the free countries in Europe being able to exist the way they do. The free market is what’s allowed everybody in the world that could do it to have liberty. Even in Russia, people have more liberty today than they did on the non-free market philosophy. So I reject that totally.

Douglas Goldstein: That is a clear explanation of really what went on, which was at the government level that you’re describing. It set up a situation that’s simply made it possible for people to try all sorts of tricks and all the shenanigans with “try and find” techniques in order to maximize their own profit, which certainly didn’t help the system as a whole.

Leo Melamed: If you look at my website www.leomelamed.com, it has many references, speeches, lectures and what-not, but there are many books on the subject and the little bit that I gave you just now can be verified in a hundred different ways by great economists who have concluded no differently than I. The free market is what we’ve got to hold on to.

Douglas Goldstein, CFP®, is the director of Profile Investment Services and the host of the Goldstein on Gelt radio show (Monday nights at 7:00 PM on www.israelnationalradio.com. He is a licensed financial professional both in the U.S. and Israel. Securities offered through Portfolio Resources Group, Inc.